Quantifying the Tightness of Mortgage Credit and Assessing Policy Actions

TLDR: Li et al. as discussed by the authors argued that if we don't solve mortgage credit availability issues, we will have a much lower per© centage of homeowners because a larger share of potential new homebuyers will likely be Hispanic or nonwhite-groups that have historically had lower incomes, less wealth, and lower credit scores than whites.

Abstract: INTRODUCTIONMortgage credit has become very tight in the aftermath of the financial crisis Although experts generally agree that it is poor public policy to make loans to borrowers who cannot make their payments, failing to make mortgages to those who can make their payments has an opportunity cost, because historically homeownership has been the best way to build wealth And, default is not binary: very few borrowers will default under all circumstances, and very few borrowers will never default The decision where to draw the line-which mortgages to make-comes down to what probability of default we as a society are prepared to tolerateThis Article first quantifies the tightness of mortgage credit in historical perspective It then discusses one consequence of tight credit: fewer mortgage loans are being made The Article then evaluates the policy actions to loosen the credit box taken by the government-sponsored enterprises (GSEs) and their regulator, the Federal Housing Finance Agency (FHFA), as well as the policy actions taken by the Federal Housing Administration (FHA), arguing that the GSEs have been much more successful than the FHA The Article concludes with the argument that if we don't solve mortgage credit availability issues, we will have a much lower per© centage of homeowners because a larger share of potential new homebuyers will likely be Hispanic or nonwhite-groups that have historically had lower incomes, less wealth, and lower credit scores than whites Because homeownership has traditionally been the best way for households to build wealth, the inability of these new potential homeowners to buy could increase economic inequality between whites and nonwhitesI QUANTIFYING THE TIGHTNESS OF MORTGAGE CREDITBefore we can discuss whether mortgage credit is tight or loose, we must be able to measure it objectively Many researchers have looked at the Federal Reserve Senior Loan Officer Opinion Survey,1 while others use the mortgage denial rate as measured by Home Mortgage Disclosure Act (HMDA) data Neither source seems very useful for our purposes The Federal Reserve survey failed to pick up the loosening of credit in 2000 to 2007, although it did pick up recent tightening (Figure 1a) The denial rate using HMDA data is even less useful; it was highest in 2007, suggesting credit was tightest then, when we know that was when it was loosest (Figure 1b) Denial rates confuse supply and demand Although the supply of mortgage credit was very robust in 2007, the demand from marginal borrowers was even greater, leading to a high denial rate in the face of loose creditWe can look directly at the mortgages originated at any point in time to quantify the tightness of mortgage credit However, many different dimensions make up credit risk The most important dimensions include the loanto-value (LTV) ratio, debt-to-income (DTI) ratio, credit score (FICO is the measure traditionally used for mortgages), and whether the mortgage is a traditional product (fixed-rate mortgage with a term of 30 or fewer years, or an adjustable-rate mortgage with more than 5 years to the reset) or a nontraditional product (interest-only loan, loan with negative amortization, 40year mortgage, or hybrid adjustable-rate loan with a short fixed-rate period where the payment is initially low and rises considerably over the life of the mortgage) In 2016, mortgage credit looked very tight when measured by FICO scores and percentage of nontraditional products; it looked much looser when measured by LTV ratios and about average when measured by DTI ratios (Figure 2)So which measure should we be relying on? Li and Goodman (2014, 8-18) constructed a Housing Credit Availability Index (HCAI) that is updated quarterly2 The HCAI measures the ex ante credit risk of the mortgages originated in any given quarter-more precisely, it measures the likelihood that those mortgages ever default, which is defined as ever going 90 or more days delinquent …